What is a Hedge Fund?

What is a Hedge Fund?

October 14, 2019

With all this talk about a recession being near, how can we make sure our investment portfolios don’t get crushed?

The fear of volatility comes when we are too exposed to one asset class (for most people it is stocks), but what if you could profit from both bull and bear markets? When stocks move up and when they move down?

That is the intended purpose of a hedge fund! The term “hedge” means to bet against, or cover your bet. So if one bet loses, the other wins. This means a hedge fund is basically an investment pool (headed by a professional manager) with the sole purpose of making a return no matter which way the market moves.

Different kinds of hedge funds have different strategies that they employ. However, most hedge funds try to make money “absolutely”. Again, no matter what the stock market does, it is their job to make you money.

NOTE: Not everyone can invest in hedge funds! They are only available to accredited investors, basically someone with over $1 million in assets (not including their primary residence) and making over $200k/year (300k combined if married).

Hedge funds CAN accept a very limited amount of non-accredited investors… but usually those spots are for family and friends only. So unless your uncle runs one, looks like you’re out of luck!

Hedge Fund FEES

Ah, the fees. Everyone wants to know what something costs before they purchase it. But hedge funds are a little different. Because you don’t know exactly how much it is going to cost per year until the year is over!

Many hedge funds use a fee structure called the 2 and 20 payout, which means you pay the fund manager 2% of the assets every year and an additional charge of 20% of the profits they make you every year. (This means that even if you LOSE money on your investment, you will still be charged the 2% minimum)

As an example, take a fund with $100 million in assets under management. The hedge fund manager would take 2% of that amount annually ($2,000,000) guaranteed. Then suppose the fund churned out a 10% profit ($10 million), the manager would take home an additional $2,000,000 (20% of the $10 million in profit).

This fee structure turns many people off from hedge funds altogether, even before looking at what the fund’s returns are. Some of the best funds in the world charge 4 and 40 (4% annually and 40% of the profits). Even after fees, these funds have historically churned out market-crushing returns in both positive and negative years for the S&P500.

Hedge Fund Strategies

There are many different types of investment strategies that a hedge fund can employ. Some of the most common are Macro, Equity Long/Short, and Quant funds.

Macro: The goal of a Macro hedge fund is to invest in stocks, bonds, futures, options and sometimes currencies with hopes of capitalizing on changes in macroeconomic variables such as interest rate movements, foreign currency volatility, global trade sentiment, and politics.

Long/Short: At a long/short hedge fund, the manager attempts to buy stocks they deem to be undervalued while simultaneously selling stocks they deem to be overvalued. This creates your typical mental image of being “hedged”.

Quant: The goal of a quant shop is to leverage technology to make investment decisions faster than other players. They use computer models to take the human element out of trading. They preach efficiency and speed. Some of the largest and most successful hedge funds in the world are quant shops.

Should You Invest in a Hedge Fund?

If you are an accredited investor looking to diversify your holdings, a hedge fund can be a great way to do that. While their performance may not outpace the stock market over the long-term, due to their high fees, they can provide you with exposure to areas outside of your current reach.

HOWEVER, keep in mind that some of the best funds in the world (Bridgewater, Renaissance Technologies, Two Sigma, D.E. Shaw) carry massive minimum investments and sometimes are not taking on any new capital at all. This may leave you looking at funds without a lengthy track record to prove their worth.

If you are a non-accredited investor, take pride in the fact that you can invest in the stock market through cost efficient means, like vanguard’s total stock market ETF (VTI), and reap long-term returns that outpace most funds.

Looking into investing in a hedge fund? Think it is pointless when you can just buy an index fund? Let me know your thoughts at the contacts below!

MDAS

If you thought this was helpful, terrible, or somewhere in the middle, please leave me feedback in the form of a Direct Message on instagram @MakeDollarsAndSense, or feel free to send me an e-mail/text to the information on my Home Page. I truly appreciate constructive criticism and opposing views, so bring em on!

P.S. New blog posts coming your way every Monday!

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